MoneySENSE 1: Financial Literacy and the Subprime Crisis

8 06 2009

Financial literacy is low not only in financially backward countries, but also in developed countries, and this may have serious repercussions. Tito Boeri and Luigi Guiso (http://www.voxeu.org/index.php?q=node/488) argue that financial illiteracy, in the form of ‘financial inexperience and myopia of consumers/investors’, is a main cause of the subprime crisis. Consumers fell for the prospect of getting a mortgage at rates never seen before and then extrapolating these rates out for thirty years. This myopia was encouraged and exploited by banks and other lenders eager to attract and retain clients. Thus began the process that led to today’s financial crisis.

With the help of the suggested readings, consider the following questions:
How did the financial illiteracy lead to the subprime crisis? To what extent can financial literacy prevent such a situation from reoccurring?

(You can just answer either one of the questions. Remember to limit your comments to 2-3 paragraphs; it’s really not worth writing a long essay! Each blog comment gets a maximum of 5 points; each correctly answered MCQ — which you will do on 27 June — gets 1 point. Please refer to the briefing slides that we emailed you for more information on the way we mark. Thanks!)
                                                                                                                                                              

Suggested Readings:
– Boeri , Tito and Lugi Guiso. ‘Subprime Crisis: Greenspan’s Legacy.’ Vox: Research-based Policy Analysis and Commentary from Leading Economists. 23 Aug 2007. <http://www.voxeu.org/index.php?q=node/488>.
– ‘The Downturn in Facts and Figures.’ BBC News. 21 Nov 2007. <http://news.bbc.co.uk/1/hi/business/7073131.stm>.
– ‘Sub-prime Mortgage Crisis’. Wikipedia: The Free Encyclopedia. 8 June 2009. <http://en.wikipedia.org/w/index.php?title=Subprime_mortgage_crisis&oldid=295086853>.
– ‘Financial Crisis of 2007-2009’. Wikipedia: The Free Encyclopedia. 8 June 2009. <http://en.wikipedia.org/w/index.php?title=Financial_crisis_of_2007%E2%80%932009&oldid=295132875>.

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29 responses

8 06 2009
Chiang Yuan Bo/ VJC/ VJC002

The Subprime mortgage crisis is the result of people borrowing beyond their means and banks allowing them to borrow beyond their means. In fact, the banks began to give zero down payment, adjustable interest rate loan without checking the background of their clients. Some of these clients excited at the prospect of owning a house, readily borrowed from the bank although in the long run ( when the adjustable interest rate snowballs at the end of their loan) they cannot afford it. This caused the subprime mortgage defaults as we know of it today. The lack of financial literacy lead to miscalculation or the lack of any calculation on their part leading to bankruptcy.

Educating the public on managing finances would help them be more prudent about their spending habits and know what they can afford or borrow. Some of these subprime loans could have been avoided. However, not all of these subprime loans can be prevented. This is because, some individuals know their financial status and have calculated they can afford to buy the home assuming that prices of houses continue to rise or remain constant. In fact, they would be quite justified in making this assumption, given that the prices of houses in the US has risen continuously for 70 years in a row! Therefore, it would seem that increasing financial literacy would mitigate the extent of the crisis but the jury is still out on whether the crisis can be averted.

8 06 2009
Lee Jun Hui / HCI / Team 9

How the low financial literacy of the Americans leads to the financial crisis has already been discussed earlier on by Yuan Bo. Here, I offer my view that the subprime crisis would not have evolved into a global financial tsunami just based on the abovementioned reason alone. It is in fact a case of “failures on many fronts” – the result of a confluence of factors ranging from financial illiteracy to problematic corporate governance and even government inaction.

For one, exacerbating the poor financial literacy of the Americans has been the role played by those financial institutions which did not do their part in checking the borrowers’ backgrounds before lending. Instead, blinded by the temptation to earn quick bucks, many institutions exploited the general financial illiteracy of the Americans, extending mortgage lending excessively and irresponsibly. Had the banks critically assessed the risk profiles of their borrowers and curbed their lending, things would not have turned out the way they are today.

There were also problems with the US rating agencies. Basically, the agencies assigned ratings based on the investment banks’ histories, which obviously did not reflect the high underlying default risks of the ‘more recent’ financial instruments peddled by banks: mortgage payments.

The above two factors are further amplified by the failure of the US government to respond to these fundamental problems in corporate governance and rating agencies. Prompt government action then could have potentially nipped the crisis in the bud, but the US government chose the easy way out, reducing the Fed funds rate instead. But by then, everything becomes too late.

The US is now paying the price for not taking heed of the old adage, “a stitch in time saves nine”.

8 06 2009
Lee Jun Hui/HCI/Team 9

Just to add on to my post, here’s a good report on the subprime crisis: http://www.igidr.ac.in/~money/BhanuMurthy_KV_Deb_%20Ashis.pdf. I find Section VI in particular on “Who were responsible for the crisis?” worth reading.

8 06 2009
LIN BO/VJC/VJC005

I think the financial illiteracy of the mortgage borrowers is one of the main causes of the crisis. This dearth of knowledge about mortgages and the financial market creates the information gap between the banks and borrowers, allowing the bank to exploit such imperfect information to earn huge short-term profits.
It is quite sad that sub-prime borrower don’t know that there is always NO FREE LUNCH: some sub-prime borrowers might simply be “happy” because banks might had “made a mistake” to give them the mortgage to buy a house. Actually it was not a mistake at all. If the house prices continued to rise, banks would be “happy” to see foreclosures: because they can just expropriate the houses and resell them to the booming market and make the profit out of the price differential!! Furthermore, banks can package the mortgage and sell it to Wall Street and simply leverage on this house to lend more mortgage!! Therefore, borrowers were “happy” borrowing and banks were “happy” lending, without knowing it was a bubble trap.
Due to this financial illiteracy, banks would be able to “exploit” the borrowers. However, when the house prices went down, everything built on this price bubble would just collapse. If the sub-prime borrowers know what is going on in the mortgage market and the banks were not “nice or stupid” to lend them the money, they would avoid such an “American Dream trap” and be more realistic about getting their houses, hence the crisis might be avoided.

8 06 2009
Li Tiantain/HCI 03

As Yuan Bo has discussed, the subprime mortgage crisis was partly due to the lack of financial literacy of the US consumers who borrowed beyond their means. On the other hand, the presence of the vastly alliterated investors in the US and even other countries has further added to the growing of this bubble. After lending money to the subprime borrowers, the investment banks pack those high-risk loans with other financial instruments to sell to the ill-informed individual investors all over the world. The packages/minibonds can be so complicated that even a well-educated person can hardly understand their exact structures. As a result, the investors get overwhelmed by the apparent high return and low risk involved, as what the advisors had told them, and dump their money into those packages without knowing the actual risk behind. This supply of fund gives the investment banks even more incentives to give out subprime loans, thinking that there will always be more “fools” to support their cash flow and the chain will go on indefinitely.

After the housing bubble burst, however, the investors found that their “high-yield” investments are literally worthless now. Their losses may even further dampen the weakening demand in economies all over the world. In Singapore only, more than $26 million was lost for the investment in those structural products, and many of these products were hold by uncles and aunties with only primary school education. Considering that educating them to fully understand the structures of these products seems impossible, we should emphasize to them more of the basic principles of investing, rather than confuse them with complex figures and calculations. General rules such as “higher yield=higher risk” should be kept in mind at all the time. After all, it is the most important principle that even the most literate investors should remember: there is no free lunch in this world.

9 06 2009
Hong Wen/DHS/DHS01

For investors who purchased the mortgage bonds, the lack of financial knowledge in understanding the products is one of the paramount factors which allowed this sub prime crisis to occur. The establishment of a mortgage bond market that is highly lucrative for bankers and it also allows some Americans who had bad credit history to buy the dream house they always wanted. Since banks can earn a sum from selling the mortgage to investors through securitization, even if the borrowers were to default their loans, the ‘time bombs’ were already passed on to the investors out there who were eager to get hold more of the so called ‘safe’ investments. If the investors had sufficient financial knowledge, they would have known the high underlying risk in the bonds and not be misled by the sweet talking and spotless packaging by bankers. Thus, with sound investment know-how, they would not have bought the mortgage bonds and created such a market of a magnitude big enough to cause this sub-prime crisis. It could have helped to prevent, or at least reduced the severity of this subprime crisis.

The lack of financial knowledge also creates uncertainty in markets among people. Some people do not fully understand financial tools and trends hence they tend to herd like a school of fish. They speculate the market by following rumors or advices from professional technical analysis this usually results in a self-fulfilling prophecy. Take for example if there was a rumor claiming that prices of, lets say, pencils will rise and we should stock them up so that we can sell it at a higher price next time. When people start to demand for more pencils, it drives the prices of pencils up. This rise in price will further confirm the ‘prophecy’ made and more people still try to enter this bubble to try to gain a share from it. The combination of the lack of financial knowledge and herd mentality will most likely create unnecessary problems.

However before one can say that the lack of financial knowledge is the main cause of the crisis, we may first need to look at certain fundamental problems that lies in human nature. We have all heard of the well known quotation: The love of money is the root of all kinds of evil. Greed is actually the real driving force behind most of the crisis that are occurring. If investors were not profit driven, they would not have bought the Collateralized Debt Obligations (CDO) from the financial institutes. The banks would not have spiced things up by providing attractive offers that lured people into getting mortgage loans. Essentially, as long as humans are greedy, economic bubbles similar to what we have experienced will likely to happen again. Drawing from real life examples, even though people know that the odds of winning any lottery is incredibly small, they are still willing to purchase that ticket in the hope of winning easy money. This implies that even with adequate financial knowledge, people might still find it worth while to risk it in order to earn some quick cash. Hence, the lack of financial knowledge should not be the main cause of the situations we had been encountering. It is human greed that is the culprit.

9 06 2009
Hong Wen/DHS/DHS01

Opps. Sorry for the length. I didn’t realise it would turn out this long.

21 06 2009
nefmq

Hey, no worries for this one. I could easily follow your train of thought, so it’s alright.

9 06 2009
Jeremy/HCI/Team 6

Previous commenters have talked at length about how financial illiteracy contributed to the current crisis, and I broadly agree with their analysis. I’m more interested in the second question on how much financial literacy can help to avert a recurrence of the crisis. I’m a pessimist on this count – what comes to mind is the list of savvy, immensely financially literate investors who fell for Madoff’s Ponzi scam, which to me is proof that all the financial knowledge in the world can’t guarantee that you’re gonna make the right decision.

I think Hong Wen is on to something when he talked about self-fulfilling speculation and greed as the driving force behind many economic decisions made by investors. No matter how sound your investment principles or how financially literate you are, the world economy is built on ironically un-economic foundations: things like “confidence”, “common knowledge” and “herd mentality” – animal spirits, to adopt the Keynesian term. These are things more in the realm of psychology than economics and finance, and all the economic theory of the past decades (dare I say the past century?), from Keynes to Thatcher, has been woefully neglectful in taking these things into account.

Not that it’s their fault – the paradigm of economics since time immemorial has been that human beings are rational economic animals. I think that paradigm is shifting as we realise that we aren’t rational a lot of the time. I’m placing my bets on behavioural economics to come up with the new dominant paradigm in economic theory that might help us avert future crisis, a theory that factors in the rooted irrationality of human behaviour. To me, faith in financial literacy is a part of the old paradigm, an attempt to make people more “rational” when fundamentally we aren’t (at least not in the way economists mean it), and is hence limited in its usefulness to avoid repeats of what’s happening now.

10 06 2009
Jamie Pang/HCI/Team 6

I agree with Jeremy that even the most financially literate of us may find that going along with the direction the economy is heading may just be what’s ‘rational’ because you may get some quick money from it and there’s really no telling when the bubble will burst.

Still, there may be some merit in the argument that financial literacy will help some remove excess confidence that things will continue forever and PERHAPS introduce some caution. Assuming it would improve the situation, I still do not think it’s a feasible short term solution that can be adopted towards the aversion of a future crisis.

How effective is education? Much less education about such sophisticated banking procedure (securitisation for e.g.)? Will people listen? Will they understand? Even if they do understand, will they remember your lessons when the next bubble comes along and something in their gut tells them that ‘hey that’s a few thousand dollars (or hundreds of thousands of dollars) to be made’?

Pardon my cynicism, but for an effective solution to the problem, you probably should look at correcting the institutions. You’ve got a better shot at that. Governments just have to assume the worst of the variables they cannot control and make the best of what they can.

Maybe that was put a little too crudely (:

10 06 2009
Chua Xin Rong/ HCI/ Team 1

Indeed, Correcting the institutions is an idea that has merit. Perhaps the fat bonuses the bankers receive should not solely be tied to profits on paper, but also be related to how likely it is that these profits can actually be realized.

The banks do not function for the good of the public, but for the good of their own pockets. Would they change the system such that they can’t benefit from the simple shifting of numbers? Would they change the system such that they can’t line their pockets while fuelling a bubble that, when it bursts, will ultimately hurt the man on the street?

So, I suppose, we turn to the government. Sadly, governments are not known for their omnipotence. They try to control these banks by lending them money, but guess what- the banks don’t want it! According to CBS news, “a handful of banks have returned a small amount of money and bigger institutions have indicated a desire to repay. ”

Yes, it is true that these banks will now need to meet yet another set of criteria before they can wriggle their way out. But this just shows the nature of the situation: it is not as simple as “I want to change you, you are changed”, but like a game of cat and mouse where the attempts of the government are constantly weakened.

Pardon my cynicism, but correcting the institutions isn’t that easy either. 😉

10 06 2009
Lee Jun Hui/HCI/Team 9

Indeed, both policies (rectifying the institutions and education) are not easy and straightforward solutions to the financial crisis.

But, should we reject these policies on the basis that they aren’t “that easy” to implement, as what Xin Rong has suggested? I believe that if the (US) government has the courage to admit the regulatory failures and the will to rectify them, sorting out the mess in corporate governance is not an impossible goal. Now isn’t the time to choose the easy way out.

Let me conclude by reiterating the familiar mantra made by virtually every Economics student in their essay, that a multi-pronged approach comprising a good mix of short-term and long-term solutions should be adopted to address the financial crisis.

10 06 2009
Jamie Pang/HCI/Team 6

Well there’s no easy solution, that’s for sure. That’s why I said you just have a better shot. Not a definite bulls-eye. The truth is, I still think that it’s more probably you’ll find a effective solution if you concentrate on the institutions, RATHER than on financial literacy (it’s a relative thing here). There has been talk on changing incentive structures of credit rating agencies, evaluating the liquidity ratios banks are legally required to keep, breaking down banks etc. It’s difficult, but I believe more plausible.

I bet the economist out there will resent us for having the luxury of criticising and not having to provide constructive policies 😀

11 06 2009
Chan Ze Ming / RIJC / TTWW

I think that to find out whether financial literacy alone can prevent the situation from occurring, the sub-prime mortgage crisis and the following recession has to be analyzed in terms of multiple stakeholders. It is a culmination of financial illiteracy, financial ignorance and corporate greed that has led to the current crisis today. Financial illiteracy refers to the inexperience of consumers/investors leading to the exploitation from the banks. Financial ignorance refers to the neglect regarded to the level of risk that companies and banks are taking by the credit rating agencies as well as the failure of the government to step in at the right time. Corporate greed refers to the banks and issuers of securities and structured products. As the others have explained these factors rather well, I will not explain them in detail.

Looking at these factors, it is obvious that a multi-pronged approach is necessary. Each factor or stakeholder alone did not lead to a crisis of this magnitude; it was how each factor contributed to the snowballing effect which caused the extent of the problems we see today. So, the solution must comprise of the following:

Financial illiteracy is a problem which has to be tackled. As we see, without much understanding of structured products, bonds and securities, banks can easily sell such products to investors, promising high yields and returns. However, the investors do not know about the risk involved and simply pump in money, supporting such continued behaviour of banks. This is a huge problem that cannot be tackled by simply educating the people. The banks must be made to do their part as well. The Minibonds problem in Singapore was related to banks and brokers selling the credit-linked notes as low-risk products, such that when Lehman Brothers became insolvent, a lot of the investors complained that the banks mis-sold the products. This is because banks and brokers do not provide accurate information about the products and so this led to people buying up the products despite the risk. So, to solve this, the government might need to pass legislation requiring banks and brokers to provide sufficient information, otherwise, the investors may be entitled to sue the banks and brokers. Although such a policy may seem highly impractical, we should implement such a policy as a deterrence to prevent future similar situations.

In the U.S., credit rating agencies gave high investment-grade ratings to the high-risk mortgage loans and securities based on the risk-reducing practices and also the confidence in the banks and brokers. So, as a result, this allowed the easy sales of all the products to investors, resulting in the huge extent of the problem. In future, these credit rating agencies must be monitored much more carefully and not be allowed to over-rate certain products, by introducing a cap for certain high-risk products. Also, more transparency is needed and the credit-rating agencies may be made to partner the government in the rating process.

The government’s failure to step in timely has led to many problems. Firstly, during the post dotcom bubble burst period, from 2001 to 2004, the Federal Reserve had lowered interest rates too much. The government also failed to regulate the finance industry despite all the looming problems and when the crisis struck, the government failed to act quickly enough to pump money into the economy to prevent the loss of confidence and fear in the markets today. Well, this problem is quite obvious so I won’t elaborate much. So, the government must continue to monitor the economy closely and act when needed. Luckily, this problem is already being rectified as we speak but it may have come too late to prevent this recession.

Lastly, corporate greed has been the motivation behind the behaviour of investors, banks and brokers. Obviously, corporate greed cannot be regulated nor stifled. When greed comes into the picture, all caution is thrown to the winds. The extent of leverage of investment and mortgage banks are just incomprehensible. It is surprising that with this extent, the government has not stepped in in some way. In future, perhaps it may be prudent to get banks to declare their risk portfolios with more transparency and allow credit rating agencies to rate them more accurately. This will give a better indication of how much risk the banks are taking up so that investors will have a better idea and the government can regulate the whole industry more carefully. Financial literacy will help here as well. If investors have a better understanding about the financial instruments, they may be less keen to support such products and without the high sales output, banks and brokers will not reach the extent we see today. We must be more wary of corporate greed and preach greater transparency to counter this problem.

Of course, the solutions are not limited to these but these are some examples how financial literacy and legislation can be used to prevent the sub-prime mortgage crisis and other problems from returning.

15 06 2009
sharron liyuan team spectrum, JJC

The sub-prime mortgage crisis happened due over- lending of funds by both buyers and investors . Few years ago, the US was facing a boom in the property market, properties was sold like hot potatoes. Both investors and buyers saw the lucrative market for this. So more houses were built to meet the high demand for them. When someone in US buys a house, they would need to get a housing loan, and they need to satisfy the basic financial requirements before the loan can be approved by the banks. However, everyone thought that since they were earning so much money already from this boom, why not sell more houses? Why not lower our loan requirements? Soon, houses were bought and loans were granted to people we will soon known as “NINJAs” which simply means, people with NO INCOME, NO JOBS and ASSETS. This shows the lack of financial literacy by the investors or property magnates to foresee the situation when buyers cannot afford to pay for the loans. This eventually happened, and due to the market cooling down, the problem got worse. Property prices fell, buyers who can’t afford don’t want to sell at a low price, banks cannot receive money. Soon, the problem perpetuates and eventually claimed it’s first victim, “Lehman Brothers”, at the same time, pulling almost every country along with them.

However, we must consider the fact that it’s the financial grads from ivy league or any other prestigious college in US working in these firms who came out with the financial equation stating that all of these that we’re facing right now won’t happened. This shows that even the biggest brains of the particular field makes mistakes. Was it pure greed then? Or pure naive thinking? I feel that even when everyone has financial literacy, we must always know that nothing is free in this world and money do not come that easily, we must not be driven by greed to make a decision , if not, no amount of whatever literacy will save us from this crisis.

16 06 2009
Lim Wei Sheng / RI(JC) / asdfghjkl

I would like to say that financial illiteracy may not have been the major cause for the subprime crisis, nor would it be the panacea to future crises of this nature.

Firstly, one must realise that financial institutions would adopt a highly technical approach to calculation of expected risk and returns. This is based on the culmination of all the work of financial mathematicians and statisticians. However, it was the mentality that risk could be computed and calculated that encouraged the industry to neglect the “human” aspect of finance, which involves discretion and experience. Would consumer sentiment be able to triumph over what would have been seen as an invincible extrapolating computational system? I doubt that majority of the bankers themselves would have challenged the results of the computation.

Secondly, it is difficult to expect financial literacy among consumers when so much of the factors leading to the mortgage crisis involved under-the-table actions that the relevant parties were more-often-than not, not aware of. Sophisticated financial instruments such as collateralised debt obligations and credit default swaps were proliferated prior to the crisis and financial stakeholders often used these instruments without paying attention or simply not being aware of the big picture of over-leveraging. It was only in the wake of the crisis, where experts surveyed the debris as a whole, did faults and loopholes surface. What I mean to say is that being merely consumers, a cog in the entire gear system of the finance industry, it is difficult to expect financial literacy to allow one to transcend their perspective and analyse systemic threats in the system.

Ultimately, financial regulators and professionals at financial institutions bear the most responsibility for their actions. Financial regulators, in particular, with their macro-view of the trends in the financial industry, should have the prerogative to stem any unhealthy practices.

17 06 2009
gabriel/sajc/$ensibilities

I do not disagree that financial illiteracy had a part in causing the subprime crisis. But as other commenters have argued, there are indeed other more significant factors to take into consideration, like the inherent flaws of business institutions and the lucrative deals hanging in front of us like carrots. I don’t think we can pin the blame on anyone or anything more than our own naivete and greed. The complexity too, of the computations and statistics which churned out these high risk financial strategies, set our minds abuzz and clouded our rationality. Who in their right mind would have thought that there would be no repercussions following a huge loan from the bank to an average Joe with no credit worthy-ness? And yet we (technically, the Americans) conveniently ignored it and took it all in. Not only ignorance, but greed too was the lead in this fiasco.

Really, if these two were the main culprits of this whole episode. Then greater financial literacy would at most rectify the problem of our ignorance. Greater knowledge of the risks involved in such financial gambles would make us think twice. We would know better now, “once bitten, twice shy” as they say.

But that still leaves us with “greed” or to put it more subtly, “opportunistic tendencies”, which is an inherent problem in society, which clouds our judgement. Itis harder to weed out than mere education. What can education do if the person in question cannot think straight in the first place right?

18 06 2009
Sam / RIJC / TTWW

Financial illiteracy alone would not suffice as the cause of the financial crisis. IMO, the root of the problem can be traced to the origins of the real estate mortgage crisis, which was due to incipient flaws in the industry itself. Within the real estate industry, the rising prices facilitated distribution of mortgages despite the fact that more than 99% of these were not returned. However, when the optimism ceased with prices peaking and starting to decrease, the financial sector began returning mortgages to mortgage firms, which subsequently began folding. The main issue with the operations of mortgage firms was that these were excessively dependent on buyer confidence and expectations in the housing market to boost price increments. Once these were undermined by market predictions or the impending possibility of reduced demand, the mortgage cycle would collapse.

The industry is also inherently unstable due to the frequency and magnitude of speculative purchases. In 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an additional 14% (1.07 million units) purchased as vacation homes. Further evidence, from the fact that houses could be sold without having occupants living in them prior to construction, attests to the speculatory nature of such purchases. Hence, this led to the creation of an economic bubble supported by unfounded optimism, similar to those triggered by the discovery of new markets or industries where demand has yet to stabilize in the formative stages.

The GSE status of many of these companies also led to another of the fundamental causes — a wanton neglect of any financial concerns that the company could run into while pursuing its objectives, because the government would always be there to bail it out. This led to situations in which the companies would seek out profit making opportunities in buying up mortgage guarantees, and rely on the government to fund these if things went awry. In the words of Krugman ‘This implicit guarantee means that profits are privatized but losses are socialized’

22 06 2009
Glen Tan / ACJC / Fiducia

I firmly believe that financial literacy can indeed help to a considerable extent, barring lapses in rational behavior which cause poor judgment and are exacerbated by the culture of greed (Easy credit and seduction by appealing ‘’teasers’’)As mentioned in earlier comments, greed was brought forth as a key factor for the crisis. It has to be acknowledged that the culture that gave outsized rewards for success and risk-taking but did not penalise failure certainly augmented the size of the problem.

If the Madoff Ponzi scheme taught us anything , it’s that when it comes to financial literacy, even the supposedly “elect” can sometimes be fooled. Perhaps especially the elect. You know the old saying; the easiest person to sell is a fellow salesperson. The Madoff debacle comes timely to teach an important lesson of the need for the layman out there to know how to properly set financial goals, develop budgets, and learn about credit and the basics of the banking so as to protect him/herself from financial fraud.Because, as Bernie Madoff has so painfully reminded us, failure to be financially literate can impact one’s entire life. It is evident that the credit binge and egregrious levels of leverage was largely responsible for the horrendous economy. Thus, I emphasize a need to give the layman a hand-up through a mixture of financial education, advice and basic banking.

In Singapore, not too long ago , an article published by a New Paper journalist suggested making financial literacy an A-level subject. In a street poll of 100 people done by The New Paper earlier this year, nine out of 10 people believe that financial literacy should be taught in schools. One reader even wrote to The Straits Times Forum page advocating the same thing – that financial literacy be made a core subject in schools rather than being relegated to supplementary or enrichment lessons.Learning how stock markets work, how unit trusts function, and how to diversify your investments at different points of your life are skills that everyone will need sooner or later. If we are made to learn about financial literacy, then maybe we won’t be caught in the situation of the many retirees who plonked their nest eggs into a single risky structured fund without knowing that they could lose it all. Long-term change in financial behaviour will happen only when personal finance is commonly taught across society. The education system has to make this an issue for all students. Right now, it’s addressed to the minority who choose it, typically through business or economics courses. It has to be as important as other prerequisites.

Most of today’s adults have suffered because they didn’t have this type of financial preparation available when they went to high school. And they’re paying for it. Failure to understand the difference between a 25-year amortization schedule and a 40-year schedule, for example, can literally cost tens of thousands of dollars in unnecessary mortgage payments. “You wouldn’t call yourself a safe driver if you hadn’t taken driver training. Why would you assume you can manage daily finances without the basics of personal finance?”

Evidence from the subprime mortgage crisis indicates that a small but not insignificant share of sub-prime borrowers in the U.S. were either speculating on rising home values or taking advantage of the lax underwriting standards. To be sure, greed and poor judgment played a role in the crisis. But the majority of those now in trouble borrowed in good faith and genuinely intended to repay their loans. Buyers systematic biases and wishful thinking contributed to soaring delinquency and default rates. Cutting-edge consumer behavioral research reveals that optimism, the desire to own a home, and other psychological factors can often override careful analysis of repayment capacity. Brokers and lenders capitalized on these attitudes in their product design and marketing techniques. The buyers disadvantage was further compounded by the complexity of the mortgage products, low levels of financial literacy, and voluminous but ineffective disclosure requirements.This implies that information asymmetries have been exploited by the intermediaries. Therefore, the sub-prime crisis underscores that education is critical.

The financial crisis has had such severe systemic effects that the global financial system went into cardiac arrest and is still dealing with the aftermath.There are many cracks in the financial system, some of which we now know, others no doubt we will discover down the road.Resolution of the most severe financial crisis of our lifetimes may otherwise soon turn out to be a Pyrrhic victory.Most importantly, we can see, in retrospect, that excessive risks were taken, excessive compensation was paid to those who took those risks, people took out mortgages and bought houses they could not afford, and there is much blame to go around for the mess we are now in. With financial literacy, people will learn how to spend within their means. In short, unless steps are taken to improve levels of financial capability, we are storing up trouble for the future. Countries like the USA regularly broadcast finance management shows like On the Money and the Suze Orman show on CNBC, maybe we could take a leaf from their book.

22 06 2009
Glen Tan / ACJC / Fiducia

Personally , my take on financial literacy and the Subprime crisis, in the era of cheap credit, when greed and gullibility is far more powerful than fear of suspicion, like sheep , many flocked to borrow money to enhance returns, parlaying this as genius. Thus, I feel there is a need to reassess risk.From being obsessed with the quantification of risk using ways such as modern computing power, over time, as instruments became more complex, a huge shift occurred. Risk was being traded to make money. From the lense that we use to look at the financial crisis, we see that lenders were greedy and people lived beyond their means. More importantly, through these explanations run the thread of risk- and how it was mismanaged. We know things like Investors who bought the wares of the financiers. As an industry, financial tools have been a substitute for human judgment and that is a huge mistake in my opinion. Mathematical models that were backward looking and based on just a few years’ data from an asset bubble determined actions. Weighing risks as well as potential returns should be part of the calculus for all decision-making. Assessing potential returns without fully assessing the corresponding risks is incomplete, and potentially hazardous, strategic analysis.Mathematical models preclude the possibility of an outsize event. In times like now, we all listen to experts like risk managers (if we assume they know more and dispense the right advice).The problem is when times become good again, you listen to the trader who is making a big profit. It is tempting to say that this time is different, that the pain has been so severe and ongoing , the lessons will be remembered. With lending locked up the world round, we desperately need some risk taking. We just don’t have to risk everything.

22 06 2009
Grace Su, vjc005

Lack of financial literacy is definitely one of the reasons why many people were affected by this global financial crisis, but I feel that there are far more compelling reasons that caused this global financial crisis.
As evident in the papers a couple of months back, Singaporeans who had bought bonds under the Lehman Bank were severely affected after the bank collapsed and this was largely caused by the lack of financial literacy, to clearly read the terms and conditions attached to these bonds and naively assume that these bonds would be guaranteed a return. Improving financial literacy among the citizens in this case would definitely prevent such incidents from happening again.
However, with regards to the causes of the global financial crisis, I feel that greed and the lack of regulation by the governments are more compelling reasons causing it. The housing bubble was artifically inflated by speculators buying more properties using other people’s money(i.e. money borrowed from the bank) and taking the gamble that property prices would continue to rise. And given that the banks had imposed very lax credit standards, people could continue borrowing despite their poor credit record. This shaped a very vicious cycle because when the housing bubble collapsed, the banks could not get back their money from these borrowers and the properties that were on mortgage were not worth much less than it was before the burst of the housing bubble. As seen in Lehmans Bank, when the bank collapsed, people could not get their money back. This global financial crisis could have been prevented if the government had stepped in to impose tighter credit standards and preventing people from spending beyond their means.
While the american economy deserves to be emulated for being world-class in many aspects, thrift and prudence is something I think they should be learning from we asians.

22 06 2009
Irene / VJC / VJC003

The technical jargon employed by many banks and other lenders, together with all the terms and conditions present in the paper, may be baffling for the average person. An unwise and inexperienced investor will be unlikely to find out more about the investment, and would most likely trust his optimistic financial advisor who is desperate to sell stocks and bonds. This is a case of imperfect information, where financial advisers withhold information so as to increase blind investors. These investors, believing the information given by the ‘experts’, sign up bonds readily but have in actuality no ability to bear the risks. Moreover, borrowers who are extremely attracted by low interest rates are ill-prepared for the consequences should they be unable to pay up due to their lack of financial literacy.

Financial literacy can prevent such a situation from reoccurring to a rather large extent as it allows people to evaluate their loans and investments with greater detail – this would prevent any financial ‘expert’ from swaying them into making blind loans and investments that they can never ever afford, thus preventing the situation. Even though perfect knowledge is unattainable, an increase in financial literacy and knowledge can help prevent the situation from escalating – the mass defaulting of loans could have been greatly reduced if people had better information on what these investments and loans were about. They would not have accepted these loans if they were financially unsound to start with, however, the problem lies that they did not realize this.

While banks’ greed in providing low interest rates and attractive investment rates to increase investors and borrowers were partly to blame, essentially the cause of the subprime crisis was due to financial illiteracy. A wise financially literate American would not be taken in to the attractive offers if they know that they cannot afford it, whereas in this scenario, the lack of financial literacy of many Americans made them assume that they can pay back whatever they owe – which is totally untrue. The result of such assumptions led to the subprime mortgage crisis.

23 06 2009
Alvin Mok/ SRJC/ M3

Financial illiteracy results in high consumption and low saving rates especially in the United States when the Federal Reserve lowered the federal funds interest rate is lowered from 6.5% to 1.0%. Because of financial illiteracy, these consumers/investors went for unsound risk management and they hold excessive leverage. Banks are willing to provide loans, which they deem are risky in the past, and when the price of the houses fall, these consumers are not able to pay the loans. As a result, the banks suffered greatly from the loss. The federal bank chose to react after the bubble burst to minimize collateral damage instead of trying to prevent or stop the burst. As a result , by the time the federal bank choose to intervene by injecting funds into the crisis hit firms for example Citigroup , the impact on the economy have been so severe which explains the magnitude of the current financial crisis.

The federal bank decision to lower the interest rate can also be questioned. This is because the low interest rate of the federal bank discourages savings. As minimum interest is earned, and economist also believe that the interest rate policy was misjudge as during that point of time, inflation was below true inflation rate. As a result with the lowering of interest and speculations, it encourages consumers/investors to purchase assets like houses for investment in future. This may not be a wrong choice of investment in the past as the price of houses have increase steadily from 1985 to 2005 from around $80,000 to $360,000, so assuming the inexistence of this housing bubble, many would assume it to be a safe investment.

A similar situation can be prevented from reoccurring because with financial literacy, consumers will not fall for mortgage frauds which were one of the major causes of the crisis. In addition, consumers can practice risk management by predicating diversification.

23 06 2009
Jing Yan / SAJC / 19-ers

I feel that the sub-prime crisis is not so much because of financial illiteracy and more of personal greed and the selfishness of everyone in the financial playing field. The whole sub-prime mortage crisis is just a bigger (and messier) version of the conventional crime concerning conmen, especially that common conman scam of the “oranges-in-the bag”. In such a case, the conman will tell the potential victim that he can help him/her to increase his/her wealth by increasing or turning your luck around with a bag of so-called “magical items” that costs $1000 (which the victim is supposed to open only after a week and discovered that the magical items are rotten oranges). These victims are usually Singaporean aunties who are just about the most shrewd people in the world (have you seen how they bargain for a piece of fish fillet in the wet market?) and the most pratical people in the world (well my mum is one such example — she’s always nagging that there’s no such thing as a free lunch in this world). In other words, these victims are far from “illiterate”. But these same people fall for such scams because the selfish conman appeals to the victims’ greed, which is generated by the promise that they will get rich without much effort ($1000 in exchange for abundant long-term future wealth). Put those big CEOs of the banking industry in the role of the selfish conman, who only cares about the large amount of money he can earn and totally disregard the unethical methods he is using to earn that money, and put those people who choose to take part in this whole system by consuming beyond their means into the role of the aunties whose practicality disappears in the prospects of gaining huge assets/getting rich with minimal effort (in the financial world, a huge assest/ getting rich consists of gaining a big house with ridiculously low mortage rates), and you get your sub-prime crisis.

The conman case study can also be applied to the DBS mini-bonds saga. The bank officers glossed over those really “tiny and unimportant” points such as those concerning the riskiness of the bonds in order to promote and sell these lethal bonds to the customers so as to get more commission. The bank officals are the conmen and the mini-bond holders are the greedy victims.

Of course there are some victims who claimed that they are innocent and they bought those bonds with full trust in the bank officer’s explanation about the important bonds. Well, I feel that the victims are not so much as innocent and more of being too lazy to research on the details of the bonds themselves and to “shop” around the differnt banks offering different investment products. It’s not as if these victims are totally financial illiterate, with many of them being white-collared workers with a university degree. And even if they are finacially illterate, they would have family members who are finacial literate (just look at how popular the business course is in Singapore’s universities). And even if you are hopelessly financially illterate, with no help whatsoever, just don’t buy the bonds! Why part with a large chunk of your savings to buy something you don’t understand? That’s not financial literacy; that’s call common sense.

23 06 2009
Lu Yang / RJC / asdfghj

A lack of financial literacy played a part in the financial crisis, but less so than overeager (or simply greedy) investors. The problem with the current crisis can be linked to a few issues. Firstly, people buying houses that they could never logically afford, but could due to low mortgage interest rates. So the average poor joe decides to buy a house and take on a huge loan, in hope that housing prices will rise indefinitely. This is akin to believing that since my pet dog has grown twice its size over the past year, it’ll continue growing forever. In other words, not realistic.

However it was less due to these people buying things they could not afford, but more due to banks even lending them the money in the first place. What made the problem even worse was investors gambling on the chance of these people defaulting on their loans, through the securities and insurances offered by other companies on these lousy loans. It would be akin to betting huge amounts of money on Singapore winning the Soccer World cup, but with slightly better odds. When these investors had big losses, the banks therefore also lost money. Hence they are now afraid to loan out money in case they never get it back again. Thus, the crisis is less a lesson in financial literacy for the common folk, but more a lesson on common sense for those rich and supposedly smart people.

23 06 2009
Kam Kay Wee / NJC / The Oppposing Team

As everyone would agree, Americans are living beyond their means and they are paying it now although the crisis has spread worldwide. Americans are known for their high amount of spending and low savings. This is partly the reason why they would need to get mortgage to pay for their houses and the reason why they cannot pay for their loans because they spend a lot and do not have much savings. If they are financially literate, they would not have jumped in to buy houses by getting mortgage loans when they notice the interest rate is low. They speculate that housing prices will rise continuously which is a mistake. They obtain mortgage loans to obtain houses. Many of them do not have the financial means to obtain.

Many of them also go for adjustable-rate mortgages without actually studying carefully the terms that go along with it. Banks on the other hand did not emphasize these terms to these sub-prime borrowers and carry a critical evaluation of the borrower’s financial ability. These mortgages enticed borrowers with a below market interest rate for the adjustment period, followed by market interest rates for the remainder of the mortgage’s term. Those who cannot afford to pay will have to refinance. However, refinancing became more difficult, once house prices began to decline in many parts of the USA which means the value of their existing houses decrease. Those who cannot pay will have to default which they did not consider initially. In the end, the banks carry out foreclosures and many people are left homeless.

4 11 2010
Lighting Optoelectronics Forum ·

vacation homes that are near quite beaches are the things that i sought after:

4 12 2010
Anxiety Depression

the best vacation homes are those that are located near the beaches, they are really cool *.;

13 10 2012
bad credit loan refinance

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